The Problem with Groupon

Or, rather, its many problems, and why they might now burn us all

The 20 most recent offers I received from Groupon ranged from City Scavenger Hunts to Private Kangoo Classes. All were for 50 to 81 percent off the list price. Unless I suddenly became starved (Arthur Treacher's!?), gay (hot yoga), divorced (massage), or Jeffrey Lebowski (bowling), there is zero chance I'd use any of them.

That's just one problem with Groupon.

Then there's the problem of the way it works when you do use it. Everyone knows the basic idea: Local businesses agree to sell a product or service worth, say, $20 for $10. Groupon then offers that deal for one day only to its gigantic list of bargain hunters. If enough of them agree to pay $10, the deal goes "live" — the merchant gets $5 and Groupon gets $5. That leaves merchants with a 75 percent haircut.

But the biggest problem with Groupon is that it can't seem to turn its novel, clever, simple idea into a real business. One that, you know, makes a profit and accurately reports its results to investors. Groupon could have been a gorgeous niche company. It could have stayed clever and small enough that it wasn't forced to offer 43-year-old suburban dads a hot-yoga class.

Now I'm worried about the very future of this company. I'm worried about June 1, when Groupon's employee lockups expire and its shares will flood the market. I'm worried that a really great idea is going to be undone by half-baked execution.

Although Groupon has been the target of many imitators, locally and nationally, what it does is tougher than it looks. Just as eBay easily withstood auction challenges from Amazon and Yahoo, the guy who moves first has a meaningful advantage. But Groupon's bigger advantage is surprisingly low tech — its army of 1950s-style salespeople provides an old-fashioned network of guys with contacts and experience that isn't easy to replicate.

The deals were attractive to customers, and the revenue growth was catnip for investors.

Groupon became the first start-up ever to raise just under a billion in venture capital. The interest was so intense that in December 2010, Groupon had an offer from Google for an absurd $6 billion, with more than half of that in cash — that would have been eight times revenues. And infinity times profit, considering the company was losing millions per quarter as it pursued revenue growth.

That's when the company started to scare me. I'd seen this movie. When a company has skyrocketing revenues and no profits, I hear the ringing of 1999.

Groupon decided to go it alone and go public. Amid reports that its attitude toward accounting was as whimsical as its daily deal summaries, the company had to cut its reported revenues in half last fall after the SEC probed its financials. Then, just before the offering in early November, the company filed its Q3 financials.

Sites like PrivCo beat the hell out of it, noting that quarter-to-quarter revenue growth had slowed to less than 10 percent (despite the billion in venture capital!) while user revenue continued to fall — a sign that robust users were already members, while the expensive-to-acquire new users weren't spending that much. PrivCo put the value of the forthcoming shares at $8. It didn't matter. The stock came out at 20 in November and immediately jumped to above 25. And then history repeated itself.

Wall Street had been guided to expect a gain of 3 cents a share for the last quarter of 2011 on revenue of just over $500 million. Instead, the company announced a loss of 2 cents a share. And then it got worse. In April, Groupon confessed to a "material weakness in its internal controls" and reduced its already-announced quarterly revenue by $14.3 million. Now the loss was 4 cents a share. The stock got killed, dropping to just above $11. Worse, the company's guidance suggested revs of less than $550 million — a tiny jump for a company whose entire story was explosive growth. I'm worried about May 14, when Q1 earnings are released.

But I'm way more worried about the original foaming at the mouth surrounding Groupon's IPO. Groupon was a great idea. It could have evolved organically and developed the highly targeted data that would have allowed it to grow its customer base but also its spend per customer, which instead has been plummeting as it adds marginal users and sends them inappropriate offers. The market wouldn't allow it.

Everyone knew this deal had problems, both with the company and with its math. And no one cared. Even as the world seems transformed by online shopping/banking/investing/dating, the truth is we're at the very earliest stages of Web 2.0. One by one, the old world is crumbling — bookstores and record stores, Blockbuster and now Best Buy. But the chaos is ushering in some of the same tendencies we saw destroy a ton of capital the first time.

When Facebook pays a billion bucks for Instagram — valuing its 13 employees at something like $77 million each — it makes some sense. It's a transformative application with a booming space its acquirer wants and can afford. And there's a company called WhaleShark that owns a bunch of small-fry coupon sites like RetailMeNot and CouponShare — it's pretty much the exact opposite of Groupon in that it provides a small discount on things that customers really do want (e.g., 75 cents off a bottle of Tide). Sounds dowdy, but I predict it'll be the single greatest Web IPO of the year when it happens, and that's saying something given Facebook's imminent launch.

These are the deals that will move this space forward. But a few Groupon implosions and the whole space could be paralyzed for years.

I believe the folly of Pets.com and TheGlobe made it that much tougher for Facebook and Google — and tons of companies we never got to hear about — to get the money and support they needed to change the world. I believe in 2.0. It's not tulips. But let's hope Groupon doesn't screw it up for us all.

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